Buying a vehicle Cash vs Financing

[spanx]

Ok, so here's the scenario:

You have enough money to buy a R300 000 car cash. But that "Cash" is sitting in a unit trust/ETF. That UT/ETF has been growing at around 20% p.a.

Do you take the money out of the UT/ETF and pay cash for the car Or finance it at lets say 12.5.% interest p.a.

Most people would always tell you to get rid of your debt first before investing. So they would probably say to take the money and pay cash.

But I would argue that my money is growing at a greater rate in a UT/ETF than what I can finance the car at and therefore it must be the better option to finance the vehicle and keep the initial investment.

Your thoughts on this?

 

[Ancalagon]

In a situation like that, it's a no brainer. Because you can earn more keeping your money where it is than it would cost you to buy the car, leave it where it is.

 

[BrokenLink]

Use 10% of the 20% it grows (R3000) and finance the car, then your investment grows with 10% per year and also pays the car.

Then after 6 or 7 years you will have a paid off car and R500 000 in the investment account. If you take the R300 000 now and pay off the car then after 6 years you still just have the paid off car worth R100 000.

If you earn 20%....keep earning it.

 

[Tacet]

Use 10% of the 20% it grows (R3000) and finance the car
If you earn 20%....keep earning it.

That's R3000 per year. I don't think the bank will be happy if you take 100 years (interest excluded) to pay off your loan.

 

[spanx]

Ok great, glad you guys agree. I thought I might have missed something obvious here. It just doesn't make sense to take that money out of the investment account.

I guess the decision would have been different if the money was sitting in a Flexi bond @ 9% interest p.a. or something similar earning less interest than what you would be paying by financing.

 

[Blue Shirt]

Use 10% of the 20% it grows (R3000) and finance the car, then your investment grows with 10% per year and also pays the car.

Then after 6 or 7 years you will have a paid off car and R500 000 in the investment account. If you take the R300 000 now and pay off the car then after 6 years you still just have the paid off car worth R100 000.

If you earn 20%....keep earning it.

This argument is flawed. After 6 years, you would have the car plus whatever you would have saved on the car payments and interest.

If you pay cash for the car, the clever thing to do would be to put the amount that the car payment would have been into the investment account.

 

[deweyzeph]

You can't think of capital growth in a unit trust as the same as earning interest. That 20% growth every year is only realised once you actually sell your unit trusts, whereas interest is earned and cashed immediately. Once you sell some unit trusts to realise your 20% growth you start killing the goose that lays the golden egg. If you earned 20% interest on a lump sum you can easily withdraw your interest and still carry on earning the same amount of interest on your capital. With unit trusts you necessarily have to liquidate your capital to realise the value of the growth.

 

[mervman]

Also when/if you sell units from the unit trust you are liable for any capital gains taxes. And that 20% growth is not guaranteed every year either.

 

[Musicmp3]

Just a question, if you pay the car off over 5 years, what will the total amount be? Probably R400k??

Doubt your investment would of grown that much

 

[Arthur]

It depends. Are you simply looking at cash, or nett assets after say 5 years? They work out very differently.

 

[TJ99]

Just some quick and simple NPV calculations:

Taking your figures and assuming a 60 month repayment and no deposit based on FNB's calculator:

The car would cost you 409921 over the term. This works out to a present value of 354 909 using a 6% inflation rate.
Say you sell it after 5 years at R100 000, that's a PV of R 74 398.

So total cost in present value terms is 280 511.

IF your investment makes 20% PA (which is a big IF), compounding once per year, it will be worth R 746 496 after 5 years. Working back to present value gives 555 378.

Thus buying the car cash would "cost" you R 555 378 now and financing it would "cost" you effectively R 280 510 now provided you get that resale value.

Financing it is a far better option IF all those assumptions bear out. Which is by no means certain, especially that 20% PA is not guaranteed. Also bear in mind taxes which would only be deducted once you cash in the investment.

*Disclaimer - This post does not constitute financial advice bla bla bla etc.

 

[deweyzeph]

In a situation like that, it's a no brainer. Because you can earn more keeping your money where it is than it would cost you to buy the car, leave it where it is.

This thinking is flawed. The OP hasn't earned anything from his unit trusts. Sure, the market value of his unit trusts has grown on paper, but the reality is that he hasn't actually earned a single cent from his unit trusts. They do not provide him with any source of income, except maybe a small dividend payment twice a year.

If you absolutely have to get this car then the clever thing to do in this situation would be to liquidate the unit trusts and use the cash to buy the car without going into debt.

Capital growth does not equal income.

 

[Ancalagon]

Just a question, if you pay the car off over 5 years, what will the total amount be? Probably R400k??

Doubt your investment would of grown that much

R300k compounded by 20% for 5 years = 300 * (1.2^5) = 746

So yes, it could have.

Compared to starting the investment from scratch again and putting roughly R6k into it every month.

 

[JStrike]

This thinking is flawed. The OP hasn't earned anything from his unit trusts. Sure, the market value of his unit trusts has grown on paper, but the reality is that he hasn't actually earned a single cent from his unit trusts. They do not provide him with any source of income, except maybe a small dividend payment twice a year.

If you absolutely have to get this car then the clever thing to do in this situation would be to liquidate the unit trusts and use the cash to buy the car without going into debt.

Capital growth does not equal income.

Exactly.
What people aren't considering is the the loan repayment will be be daily compounded interest.
Your unit trust are merely capital growth (With some meager dividends)

 

[Skerminkel]

...

Most people would always tell you to get rid of your debt first before investing. So they would probably say to take the money and pay cash.
...

Interesting discussion!

On the semantics of the quote: You are not actually in debt if your assets are more than your liabilities. What you will be doing is utilising someone else's money, which you get at a cheaper rate than using your own. Good investment then.

 

[deweyzeph]

Interesting discussion!

On the semantics of the quote: You are not actually in debt if your assets are more than your liabilities. What you will be doing is utilising someone else's money, which you get at a cheaper rate than using your own. Good investment then.

Except that in this case using someone else's money is not actually cheaper than using your own. Trying to offset interest incurred from debt with capital growth from an investment is a sure fire way to lose money.

 

[JStrike]

Interesting discussion!

On the semantics of the quote: You are not actually in debt if your assets are more than your liabilities. What you will be doing is utilising someone else's money, which you get at a cheaper rate than using your own. Good investment then.

If he was getting 20% ROE, sure I would agree. But he is only getting 20% capital growth

 

[Ancalagon]

If he was getting 20% ROE, sure I would agree. But he is only getting 20% capital growth

Return on Equity?

 

[deweyzeph]

Return on Equity?

Yes, return on equity is a measure of actual income earned from an investment as opposed to capital growth. So if the OP was earning 20% a year from dividends earned on his unit trusts that would be a very different story to 20% capital growth.

 

[JStrike]

Return on Equity?

Yep. Lets say he has invested R300 000. If he is earning R60 000 a year on that (As well as capital growth), then he should leave his money there.
But if he is just getting capital growth, then he will be losing out against daily compounded interest on the loan (At a fairly high rate)